I'm not an art fan. I lack taste. However, I did visit the High Museum of Art in Atlanta a couple of months back. I came away impressed with the collection of fine Dutch art and the painting of the Girl with a Pearl Earring. Looking and learning about art for the first time was a great experience. It gave me a chance to stop thinking about investments for a day and let the other side of my brain get some needed exercise. On the other hand, it seems like Dan Loeb enjoys mixing art with investing. He personally is a fierce collector of art and has highly prized pieces in his Third Point office.
And now, he has added another piece of art to his collection at Third Point-- Sotheby's (BID). Loeb recently filed a 13D showing a 5.7% ownership of Sotheby's and is planning to go activist on the company.
Dan Loeb Buying Activity of Sothebys
Enter the World of Fine Art
In case you are not familiar with Sotheby's, the company is an auctioneer of fine art, decorative art and jewelry. Think of eBay (EBAY), but only stuff you can't afford. It's an easy to understand business with a huge moat. In 2012, it held 46% of the global market with Christie's (a private French company) being its only major competitor. There are small auction houses here and there, but nothing that can take market share from the two big players.
The majority of revenue comes from the Auction segment, where Sotheby's collects commissions on the items sold at its auctions. While this has translated to gross margins in the mid 80% range, it has not trickled down to net margins very well.
Sotheby's Gross, Net Margin – 10 Years
The company has a history of lumpy operations making it difficult to gauge and predict.
What I See in Sotheby's
Business and Intrinsic Value Estimate
Dan Loeb obviously chose to target Sotheby's because he sees potential in an area he is familiar with. I'm sure he sees upside despite the current consensus that Sotheby's is overvalued.
At the moment, the most I see is the following:
- An inconsistent company due to the items it auctions
- Regularly dilutes shares
- Lots of cash and assets on the balance sheet
- Manageable debt
- Lots of working capital
Art is not a high turnover item, especially those that go for millions of dollars. But there is an interesting sign that I see from the inventory numbers. It shows that art is high in demand at the moment.
If you take a look at the Days Inventory Outstanding (TTM), it shows 364 days. A full turn of inventory is taking just one year to clear compared to a peak of 760 days back in 2009. You can see from the numbers below that inventory days has declined every year since 2009.
Sotheby's Cash Conversion Cycle | Click to Enlarge
Additionally, Sotheby's' business model also shows that they pay the sellers of the art at a very slow rate. This puts them in a very healthy cash surplus position. It's why you see such a high cash balance on the balance sheet. In the latest quarter, cash made up 25% of total assets.
What is Dan Loeb Thinking?
Sotheby's owns real estate in New York and London and in May 2013, the company went out to get the NY property assessed. Unless the real estate is on the books at zero, I don't think Loeb's purpose is to monetize real estate. It wouldn't move the profit needle far enough. He made well over 100% on Yahoo (YHOO) and more than 50% on Herbalife (HLF). I'm sure he isn't after a 20-30% gain on Sotheby's.
The only conclusion I can come up with at the moment is that he wants to improve Sotheby's' inability to profit consistently, and especially in times of high art demand. The market is made up of two players so any growth has to come at the expense of Christie's. Besides, taking market share is more difficult than improving operations.
My Wild Projections
The current EV/EBITDA of 13.5 is in line with eBay, which is 13.8. The only other comparable I can come up with is Liquidity Services (LQDT) with an EV/EBITDA of 10. Since Sotheby's has a massive moat, let's just say Loeb sees Sotheby's trading at an EV/EBITDA of 20. The highest it has ever traded was at a multiple of 17. That makes the target price $68.70, which is a 50% upside from current prices. That's a lofty projection I just applied, but let's see how this unfolds because I don't get it.
Dan Loeb is smarter than me anyways.